NASD Rules Preempt State Law
Arbitrators who resolve investor disputes with stockbrokers do not have to comply with California’s tough ethics rules governing disclosure of their ties to the industry and the grounds under which they may be disqualified, the state Supreme Court ruled Monday.
In a unanimous decision, the high court said California instead should apply the narrower disclosure and disqualification rules set forth by the NASD, the brokerage industry’s national self-regulatory body.
The Securities and Exchange Commission oversees the arbitration rules of the NASD. Citing that SEC oversight, the California Supreme Court said the federal Securities Exchange Act and the NASD rules based on it take precedence over a 2001 California ethics law and resulting regulations.
The U.S. 9th Circuit Court of Appeals had made a similar ruling in a separate case in March.
“We are very pleased,” said Linda Fienberg, who oversees dispute resolution for the NASD, formerly the National Assn. of Securities Dealers. “This really will allow us to perform a uniform and consistent arbitration service throughout the country.”
Arbitration is billed as a quick, affordable alternative to a court trial, and almost all brokerage houses require its use to settle disputes. Under NASD rules, disputes of $50,000 or more are heard by three-member panels -- one representative from the brokerage industry and two others from the public.
Critics have long contended that the public members on these panels frequently have undisclosed ties to securities firms through their business or legal associates.
The California Judicial Council, which sets policy for the state’s courts, required arbitrators in July 2002 to divulge a checklist of all business, personal and professional ties that could represent conflicts of interest. Investors could use such disclosed material to challenge and disqualify proposed arbitrators.
By contrast, the NASD has potential arbitrators answer a standard set of questions, and uses that to generate disclosures for parties in disputes and their attorneys to use in challenging arbitrators.
The NASD refused to comply with the California rules. More than 2,000 requests for arbitration of brokerage disputes have been made in California since the new policy, but the NASD has appointed arbitrators only if the claimants waive their rights under the state ethics rules.
About 200 of the cases have been held up because the claimants refused to waive their rights under the state rules, Fienberg said. Many of those claimants sued in state court, including an investor whose case against Beverly Hills-based brokerage JB Oxford & Co. was ruled on by the state Supreme Court on Monday.
Most of those cases presumably will now proceed under the NASD rules, although the state court decision won’t be final for a month and appeals could be made to the U.S. Supreme Court.
Enforcement of the California rules would have disqualified many people associated with the securities industry from serving as arbitrators, and could even have challenged the right of the NASD and the New York Stock Exchange to appoint panelists because of potential conflicts of interest, said Les Greenberg, a Culver City attorney who said he has represented brokerages and customers before arbitration panels during the last 28 years.
Through a spokesman, California Atty. Gen. Bill Lockyer expressed disappointment in the ruling. Spokesman Tom Dresslar said Lockyer believed the state rules “provided greater assurances that the process was fair and free of conflicts of interest.”
